1099 or W-2? The Answer Is Becoming More Complicated

The Department of Labor (DOL) is changing the way small companies can classify workers as either employees or contractors. Employers need to understand the new rules because they re-define employer-employee relationships and could reshape the gig economy and potentially have even broader implications.

An Overview 

Under the latest DOL directive, identifying and classifying workers as independent contractors is becoming more stringent. Before this law, businesses classified their workers based on straightforward criteria. (That’s not saying it was easy because the National Employment Law Project estimated that 10-30% of employers misclassified their workers in 2020.) Now, the DOL has reverted to a prior, more nuanced approach. This method examines the entire context of the working relationship and the worker’s skillset to determine whether the worker was defined as an employee or a contractor. Consequently, we expect more people to become employees instead of independent contractors. 

If you have contractors that have to be reclassified as employees, you are looking at significantly higher operating costs. Employee benefits and taxes that previously didn’t apply to contractors will now become a significant consideration in terms of overhead. 

Additionally, businesses must meticulously document worker relationships, requiring additional administrative efforts. The DOL hopes to safeguard workers, but doing so will burden small businesses in several ways.

The ABC Test 

The introduction of the federal government’s new rule does not override state laws, which maintain their criteria for worker classification. In certain states, the requirements are even more strict. For instance, California and Massachusetts employ the ABC test, where a business must validate three key aspects to classify a worker as a contractor: that the worker is autonomous from the company’s control, that the worker is performing tasks beyond the company’s primary business, and that the worker’s company provides the same services to others. 

This dual layer of federal and state regulations presents a new challenge for businesses, particularly smaller entities, without dedicated legal support. The risk of misclassification brings potential audits, fines, and lawsuits that could damage a company’s standing and financial position. These regulatory changes might adjust how businesses collaborate with freelancers and contractors, potentially diminishing independent work opportunities. For the workforce, while there may be an increase in job security and benefits, it could also restrict their flexibility and limit their opportunities with multiple employers. Both sides must will have to adapt to these legislative changes.

The Economic Reality Test 

Previously, under the Trump Administration, the DOL had provided some guidance regarding worker classification. This, however, is being replaced with this test. It offers six specific factors to evaluate when determining whether someone works as an employee or an independent contractor. It emphasizes that the decision shouldn’t hinge on a single aspect of their work arrangement. 

1. Opportunity for profit or loss depending on managerial skill
2. Investments by the worker and the potential employer
3. Degree of permanence of the work relationship
4. Nature and degree of control
5. The extent to which the work performed is an integral part of the potential employer’s business 
6. Skill and initiative

The DOL offers detailed explanations on each of these and provides examples that you can read here. It’s a layered process that demands employers to be meticulous in their analysis to adhere to labor laws accurately.

FuseCFOAdapting to these regulatory shifts may seem daunting for business leaders and managers. However, navigating these changes doesn’t have to be a solitary journey. Ensuring compliance with the law can prevent significant headaches and fines later. Reach out for a free business analysis today to smoothly transition through these changes, keeping your business on the right side of compliance and ahead in the competitive market.